Tokenization Could Pose Risks to Financial System, FSB and BIS Warn

• The Financial Stability Board and the Bank for International Settlement both flagged tokenization risks in new reports.
• "Tokenisation could have implications for financial stability if it scales up significantly," Klaas Knot the FSB chair said in a letter addressing the Group of 20 nations.

The Financial Stability Board (FSB) and the Bank for International Settlements (BIS) both highlighted in recent reports what they see as risks from tokenization and called for more regulation.

Tokenization is the digitization of real world assets including securities that often involves distributed ledger technology. The FSB, which monitors and makes recommendations for the financial system, identified three vulnerabilities of tokenization: "The underlying “reference asset” that has been tokenised; the participants in DLT based tokenisation projects; and new technology as well as its interaction with legacy systems," its report said on Tuesday.

"Tokenisation could have implications for financial stability if it scales up significantly, if it is used to create complex and opaque products that trade in an automated fashion, and if identified vulnerabilities are not adequately addressed through oversight, regulation, supervision, and enforcement" Klaas Knot the FSB chair said in a letter addressing the Group of 20 nations. The FSB also released an update on its crypto roadmap that said most countries had implemented its measures for the sector but warned against inconsistencies.

Nations around the world have been exploring tokenization. The FSB highlighted tokenization as a priority for monitoring earlier in the year. Meanwhile, more than 40 firms joined the BIS, to explore tokenization for cross border payments in September.

The BIS, the global standard-setter for banking regulation, issued a report on Monday with its Committee on Payments and Market Infrastructures to the G20.

The BIS report noted that tokenization could have numerous benefits such as reducing frictions from using different systems to trade assets but it added that existing system risks like credit and liquidity risks and cyber risks could apply to tokenization.

"These risks may materialise in different ways due to the effects of token arrangements on market structure, e.g. due to a change in the roles played by intermediaries when previously separate functions are combined on one platform," the BIS report said. Plus, conflict of interest could also emerge, the report added and called for sound governance.